Question

Lane Industries is considering three independent projects, each of which requires a $2.3 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here:

Project H (high risk):	Cost of capital = 16%	IRR = 18%
Project M (medium risk):	Cost of capital = 9%	IRR = 7%
Project L (low risk):	Cost of capital = 11%	IRR = 12%

Note that the projects' costs of capital vary because the projects have different levels of risk. The company's optimal capital structure calls for 40% debt and 60% common equity, and it expects to have net income of $4,500,000. If Lane establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to 2 decimal places.

_______%

Answer 1

Answer :- Dividend Payout Ratio = 38.67%

Calculation :-

We select Project that have IRR > Cost of capital. In our Case Project H & L satifies this. so we take these 2 projects.

Total capital required = 2,300,000 * 2 ==> 4,600,000

Investment = $4,600,000

debt weight = 40%

equity weight = 60%

Net income = $4,500,000

Dividend = Net income - (Investment * equity weight)

Dividend = 4,500,000 - (4,600,000 * 60%)

Dividend = 4,500,000 - 2,760,000

Dividend = $1,740,000

Dividend payout ratio = Dividend / Net income

= 1,740,000 / 4,500,000

= 0.3867 or 38.67%